Recent events in the oil and gas industry indicate we’re not far from hitting the bottom of the market. That’s why in today’s Insider Alert we look at four different ways to position for a potential big payoff from the next stage of the cycle.
June 2008: US$156.62 per barrel. Remember that? Almost 10 years ago.
Offshore oil and gas rig workers made more money than God, who I’m told makes a lot. In fact, I’ve a funny story to share with you.
It dates back to 2012 when a neighbor of mine in Thailand was working on a rig in the Caspian. Like so many of these guys who worked one month on and one month off… but since the Caspian is well… the Caspian, he kept his family in a luxury community in Phuket instead. Let’s face it, the only reason to be in the Caspian is if your plane’s been shot down and you’ve no other choice.
In any event, his employer was so starved for human capital that they were hiring university grads who, according to my friend, were worse than useless. One in particular was interviewed and came straight out with the following:
Candidate: “Thanks for interviewing me. By the way, I’ve just been fired from (some previous firm I don’t recall now).”
Candidate: “Well, there was a woman I worked with, and I’m young and have needs. So I would fondle myself in front of her and the team.”
Interviewer: “Mmmm. Well we don’t have any women on the team you’ll be working with. So long as you can promise me you’ll refrain from fondling yourself in front of the team – all of them men – then you’ve got the job.”
And this is how it was. You could have had three heads, a rap sheet that would make a Columbian drug lord blush, but so long as you had some skills, you were good to go.
I encourage you to go read this. Some snippets from the article to provide context to this alert:
“The amount of money they are making an hour is just mind-boggling now, just five years ago they were making just half that,” said Roberts, who moved to Singapore this year from Texas. He said his pay more than doubled in 1999 when the industry faced a labour shortage like the one that appears to be emerging.
“What we are seeing now is an acute shortage of people actually with applied skills, from engineering or chemical backgrounds,” James said.
“Even if the skills do exist globally, they don’t necessarily exist in the place that is needed. So what we are doing is we are picking up people from all corners of the world and we are sticking them into projects, whether it’s short-term or medium-term, but where they can earn reasonable money, live in a different country, live offshore, whatever that may be.”
That was then, and this is now. Today, finding work in this space is tougher than a 4-day old Burger King, and many have been laid off, including my friend who’s gone on to doing other things.
I believe we’re at (or damn close) to executing the perfect trade. You know what that would be? Taking a number of unemployed, yet skilled rig workers and buying options on their future incomes over the next 10 years. I suspect that they’d willingly take a few hundred bucks a month in stable income in return for, say, a 50% share in their future earnings.
Since we can’t do that, we’ll have to try another angle – a more… ahem, traditional one.
The Trade: Buy SPDR S&P Oil & Gas Exploration & Production ETF (XOP) around US$30 with a 3% weighting. Place bids GTC to increase holdings by 25% at US$27.50, US$25, US$22.5, and US$20. So if SPDR S&P Oil & Gas Exploration & Production ETF was to fall to US$20 over the coming weeks you would have taken a 6% exposure to SPDR S&P Oil & Gas Exploration & Production ETF.
Insider is not just about identifying “the one big trade” but rather identifying a range of trades to express the view, each with dramatic upside. It is hoped that you, my subscribers, will take into account your own risk profile before choosing which trades are most appropriate for your portfolio.
We believe it won’t be hard to at least double our money on SPDR S&P Oil & Gas Exploration & Production ETF within the next 5 years. However, it isn’t a massive payoff trade. 100% over 5 years is certainly better than a poke in the eye with a sharp stick, but it’s not subprime stuff.
For those that applaud risk and are happy to take on volatility with the potential for huge upside look at:
- The offshore oil sector with equal weight positions in Transocean (RIG), Ensco, (ESV), Rowan Companies (RDC), and Diamond Offshore (DO),
- Offshore service companies: Gulf Island Fabrication (GIFI), Geospace Technologies (GEOS), and Helix Energy Services (HLX)
- Special situations: Long term warrants on Stone Energy and Tidewater (the show stopper trade that no one knows about).
Timeframe for position: 5 years
My Line of Thinking
In this Trade Alert, I want to discuss a number of different ways of expressing a bullish view on oil stocks and, by default, the price of oil.
But first… why a bullish view on oil stocks in general?
Because I wouldn’t dare be short them at these levels for any length of time. I know this sounds very simplistic, but I am well aware that when everyone thinks alike the opposite is most likely to happen (because there are few left to think alike). Also, keep in mind that every bear market is the author of the next bull market.
We are staring down the barrel of a bear market in oil stocks that is now rivalling the GFC. That’s significant, and those of you who’ve been with us for some length of time probably knew this was coming as we’ve been discussing this sector for over 6 months now – waiting patiently and watching.
You may ask, what is going to lead to a turn in the fortunes of oil stocks? What is going to start the next bull market?
Let me not kid yourself (or myself)… I don’t know and I am not going to bother to try to guess.
It is almost impossible to tell what event will signal the bottom of the market. It is almost like trying to pinpoint the proverbial “final straw” that breaks the camel’s back.
There are many events – from geopolitical to a loss of faith in fiat currency all the way down to the very real fact that the fundamentals for the offshore drillers is alarmingly good.
We have to remember that stock prices are forward looking. They are largely based on what the crowd expects earnings to be (and the sustainability of those earnings) about 12 to 18 months out.
If we are going to wait to see positive news flow, then we’ll almost certainly lose an easy 100% move. Given that our timeframe is 5 years plus we’re quite comfortable beginning to build our positions here and now.
All that said, there are many things happening beneath the scenes – particularly from a contrarian perspective – that indicate we have either seen the bottom of the market or that it isn’t too far off… and that the next big move in oilers will be to the upside.
1. Sentiment towards oilers is toxic. The average oil stock has fallen by as much as it did during the GFC over the last 3 years – down some 60%. SPDR S&P Oil & Gas Exploration & Production ETF (XOP) is in the top 5 shorted ETFs, and its cousin Market Vectors Oil Services ETF (OIH) is not far behind.
If for nothing else, the average oil stock has the capacity to post a huge rally just on the back of short covering, if the news flow turned out to be a little less worse than expected.
2. Capital expenditure and development on conventional oil and gas wells (notably of the offshore variety) has dropped to “generational” lows. All the development activity has been focused on fracking, where everyone seems convinced (or at least is behaving) as if this resource will be in endless supply.
3. Development of shale oil reserves has focused on “sweet spots” leading to cheap sources of shale oil and natural gas being depleted first. It is going to get harder and more expensive to keep up the same production rates as sweet spots are depleted.
4. Depletion rates are exceptionally high for shale oil and natural gas wells – about 60% depletion within the first 1-2 years and often as high as 85%.
5. Demand for crude and especially natural gas continues to grow. Yes, I know the beardies tell us the electric car changes everything, but pray tell what powers one of those things? Electricity? Base load still comes from coal, nuclear, and natural gas. Wind? Nope. Won’t work either, completely aside from their unmatched ability to mulch baby birds and keep anyone within a 15 mile radius awake with their incessant humming, they don’t produce enough juice to power Al Gore’s home let alone the electrical grid. And of course, they produce nothing at all when the wind drops, leaving poor Al to count his money in the dark.
6. So you have depletion of shale reserves a lot quicker than expected but prolonged under development in offshore capacity and demand rising. A recipe for oil moving materially above US$100 barrel.
7. Funding for fracking developments will be harder to obtain as the cost of capital rises. Returns from fracking projects hasn’t been great and it has been assisted by the low cost of capital that has seen the proliferation of the fracking industry.
8. Bankruptcies galore! There have been a number of high profile bankruptcies with the latest being Seadrill (near to a done deal). And there have been too many smaller bankruptcies (thanks for coming, shareholders!) to mention.
High profile bankruptcies, or lots of bankruptcies in general, are beautiful things. Like a delicious Sunday roast when you’re famished, because, of course, they’re usually associated with a turn in the market. It is almost the exact opposite of the TMT listing boom that occurred in 1999 and early 2000.
With many oil stocks trading at record lows (or at least the lowest levels in a generation) it would seem the market is expecting many more bankruptcies.
9. M&A action is picking up. Bigger players are beginning to swallow smaller players at bargain prices. The latest big deal was Total acquiring Maersk’s assets. Ensco and Transocean have been busy buying smaller rig operators (Atwood and Songa). Bugger damn, just as we were diligencing Songa for this alert. Exxon has also done a few big deals. This signals that the bigger players are not afraid to start deploying capital after going into lockdown over the last few years. We’ve seen this before, and while we may be early the risk/reward here and now is favourable.
10. Many mid and small-cap oilers are approaching their GFC lows which coincided with the lows of 2016. The strength of this support level should not be underestimated.
11. Just over half (55%) of the oil and gas stocks in the US are trading below book value and 50% are making losses. This cannot go on as there will be more bankruptcies, less capital expenditure, and more capacity shutdowns… and ultimately more restriction of supply.
In addition to this, of those companies currently making losses, analysts are forecasting that 80% will continue to be making losses 3 years from now.
I look at the dividend yields of the Majors:
- Exxon: 4%
- Eni: 6%
- Chevron: 4%
- BP: 7%
- Shell: 7%
- Total: 5.3%
- Statoil: 4.7%
It doesn’t take a genius to workout that these valuations are getting rather attractive.
The View vs. Application of the View
I think this “view” is the easy part. Everyone has a view or an opinion. Some are right and some are wrong. Where things get real tricky is how best to apply this view. It gets even more trickier for me writing this alert as I am aware subscribers have varied risk profiles.
So what I am going to do is detail a number of different ways of expressing a bullish view on “oil being materially higher within the next 5 years”.
Yes, I will give my opinion as to which trade has the best payoff, but I stress that it is up to your discretion to choose which trade suits your risk profile.
Trade Option 1
Our Base Case Trade (for the Conservative Type): Buy SPDR S&P Oil & Gas Exploration & Production ETF (XOP)
An ETF of 60 US listed oil and gas stocks equally weighted (so Exxon has the same weighting as Rice Energy).
This ETF gives you exposure to the performance of the “average” US oil and gas stock. And that “average” oil and gas stock is down some 60% from its peak, 30% this year and is a mere 15% away from its GFC lows.
I note that the GFC lows happened to coincide with the lows of 2016. I think this is a very strong support level and I am willing to eat my leather hat if it falls below this level.
Now give this some thought: oil and gas stocks have been through a bear market that is more or less equal to the GFC. So if you are “bearish” oil and gas stocks now (i.e. willing to bet that they will go down further), then you are essentially positioning for something worse than the GFC… or you need something worse than the GFC to push these stocks materially lower.
There are other ETFs out there like Energy Select Sector SPDR ETF (S&P oil and gas index weighted by market cap) and VanEck Vectors Oil Services ETF (oil and gas services weighted by market cap). I feel there is much better value in the smaller cap oil and gas stocks and more upside, and that is why I prefer SPDR S&P Oil & Gas Exploration & Production ETF.
And leveraged ETFs like Direxion Daily S&P Oil & Gas Exp. & Prod. Bull 3X Shares (GUSH). The answer is short: don’t touch them with a 40 ft. barge pole. These are horrible creatures for any long-term investors. They are designed for short-term traders, not someone trying to express a long term bullish view.
The only way Direxion Daily S&P Oil & Gas Exp. & Prod. Bull 3X Shares would perform well is if SPDR S&P Oil & Gas Exploration & Production ETF were to go up in a linear fashion, and that, my friends, will only happen when politicians become trustworthy. In other words, never. Getting the direction of SPDR S&P Oil & Gas Exploration & Production ETF right is difficult enough without the added burden of the behavior of that direction.
Sometimes I get the feeling that buying an ETF is a bit of a “lazy man’s” way of trading. A bit of a cop out for not doing the hard yards of fundamental analysis to figure out which stocks are most undervalued and which have the most upside.
But in situations like this when the market is in an extremely oversold condition and all stocks offer value perhaps it doesn’t pay to try and be too smart and just buy the whole sector.
If you think buying SPDR S&P Oil & Gas Exploration & Production ETF is a cop out… well, in buying SPDR S&P Oil & Gas Exploration & Production ETF, you are making a conscious decision to buy the performance of smaller cap oilers rather than large cap oilers. Energy Select Sector SPDR Fund (XLE) is highly concentrated towards Exxon and Chevron (40%).
Trade Option 2
Options on SPDR S&P Oil & Gas Exploration & Production ETF
There are a multitude of ways to express bullish views on SPDR S&P Oil & Gas Exploration & Production ETF via options. Let’s discuss three ways.
A bull call spread. Buying the January 2019 US$30 strike and selling the US$40 strike. This would cost about US$3 for the spread. And if SPDR S&P Oil & Gas Exploration & Production ETF was to close at US$40 come January 2019 (a 30% move), it would equate to just over a 200% return. You would breakeven at US$33.
- Pro: That is a respectable payoff – with a 30% move in SPDR S&P Oil & Gas Exploration & Production ETF generating a 200% return in the option strategy. The maximum risk is what you pay for the spread.
- Con: Only when there is no time value left in the option sold will the maximum return be achieved. Realistically, you have to hold this option until expiry to achieve the true benefit of the bull call strategy. Is 18 months enough time? Seems a long time but markets can go sideways way longer than you think.
An ATM Call. Buying the January 2019 US$30 strike call at US$4.0. We can romance with how high SPDR S&P Oil & Gas Exploration & Production ETF could go by and what the payoff would be. But if SPDR S&P Oil & Gas Exploration & Production ETF was to get to US$30 at expiry, then it would be a 150% return and 200% at US$42.
- Pro: The sky’s the limit in terms of payoff. Of course, if SPDR S&P Oil & Gas Exploration & Production ETF decided to rally materially well before the option expired the return would be greater because there would be time value in the option.
- Con: 18 months is just not long enough for me to be comfortable on this trade.
An ITM call. Buying the January 2019 US$20 strike at US$11.35. If SPDR S&P Oil & Gas Exploration & Production ETF was to get to US$40, then this would equate to a 76% return. And if SPDR S&P Oil & Gas Exploration & Production ETF was to close at US$30 come January 2019, then you would about 12%.
- Pro: So this trade effectively would give you a 2:1 gearing effect rather than owning SPDR S&P Oil & Gas Exploration & Production ETF outright.
- Con: If we got our timing on SPDR S&P Oil & Gas Exploration & Production ETF wrong (not hard to do) and SPDR S&P Oil & Gas Exploration & Production ETF closed at US$25 come January 2019, then we would lose about 60% on the trade.
My overall thoughts on these option trades: You can hold me to SPDR S&P Oil & Gas Exploration & Production ETF being materially higher on a 5-year view ( I wish I could get a 5-year option on SPDR S&P Oil & Gas Exploration & Production ETF). But 18 months? That is way too short for me to breathe easy so if I was to do it, I’d position size it at a fraction of my overall oil & gas position.
Buying SPDR S&P Oil & Gas Exploration & Production ETF on Margin: I don’t think there would be too much risk in buying SPDR S&P Oil & Gas Exploration & Production ETF with 2:1 gearing. I.e. with US$10,000 buying a US$20,000 position in SPDR S&P Oil & Gas Exploration & Production ETF. You would only get a margin call if SPDR S&P Oil & Gas Exploration & Production ETF was to drop about 50% – i.e. down to US$15. The ultimate low at the worse of the GFC and early 2016 was US$23.8. Could it get to US$15? Stranger things have happened! It would be a crime to not have funds on hand to meet a margin call if it got down there because that would be a once in a lifetime opportunity to buy oil and gas stocks.
If you did want to increase your payoff, then perhaps one could get a little more focused in terms of the the sectors to focus on.
Trade Option 3
Buy Offshore Oil Drillers: Rowan(RDC), Ensco(ESV), Transocean (RIG), and Diamond Offshore (DO) in equal amounts
This is a really, really unloved sector right now. The only people I know of that are bullish this space are the newsletter sellers who’ve been bullish commodities, gold, and oil for the last 20 years plus. And to be frank, they’re no different than used car salesmen who will simply sell you what’s on their lot. If what you’re selling has always been gold stocks, oil stocks, or whatever the hell it is, then that’s what you sell.
Here’s something to think about: Pick a handful of dedicated offshore drillers, short them in equal portions, and hold those positions short for 5 years. Do you think you could do that and sleep at night? I certainly couldn’t. We’re looking at the opposite side of that trade.
Right now, the market is essentially pricing the offshore oil drilling stocks for bankruptcy. The average P/Book of Diamond Offshore, Ensco, Rowan, Noble, and Transocean is about 0.2x.
All these stocks have to do is simply avoid bankruptcy and their stock prices will explode higher given time.
But can an industry go bankrupt? The short answer is yes. The US coal sector essentially went into bankruptcy over the last 5 years. Remember Peabody, Arch Coal, Alpha Natural Resources, Patriot Coal, Walter Energy, and Xinergy? Well, they all left the dance floor and haven’t come back (shareholders were wiped out), although the underlying businesses continued their daily operations.
However, whether or not an industry goes bankrupt (or at least equity holders get wiped out) largely depends on the amount of debt burden companies carry.
Coal companies were carrying high debt loads. Today, most of the offshore oil drillers carry low debt loads and have high cash reserves, and most of the offshore oilers are still managing to post positive earnings and have positive free cash flow.
The oil industry is paying little attention to developing reserves it already has and is even less energetic in looking for new reserves. As an example, Conoco is more or less giving up on offshore business altogether:
Here is an excerpt from that article:
And what happens at Conoco is being mirrored by other majors (no wonder offshore oilers are struggling). As a consequence to this behavior the Paris based IEA has recently warned:
And 6 months or so ago, BHP more or less had the same warning:
Now, how about this: The least oil resources discovered in two generations. This is on an absolute basis not “per capita”. In other words, there is a lot less oil and gas discovered now than there was 60 years ago.
It seems that the oil industry has been resting on the laurels of the “boom” in fracking:
There were only 174 oil and gas discoveries worldwide last year, compared with an average of 400-500 a year up until 2013, according to IHS Markit, the research group.
The slowdown in exploration success shows that the world is likely to become increasingly reliant on “unconventional” resources such as US shale oil and gas to meet demand for energy in future decades.
The typical time from discovery to production is five to seven years, so a shortfall in oil and gas discoveries now implies tighter supplies in the next decade.
Take a careful look at the chart below. The US has become a net producer of crude and natural gas but this is only due to the fracking “revolution”.
Here is the big issue: Just what will be the production of oil and gas from fracking sources over the coming years (let’s say 10 plus)?
It seems like the EIA (and their followers) are projecting the production characteristics of the last 5 years into the future (as in the next 25 years). And don’t take this lightly. Obama didn’t in his 2012 State of the Union Speech:
We have a supply of natural gas that can last America nearly 100 years, and my administration will take every possible action to safely develop this energy,” he said. “Experts believe this will support more than 600,000 jobs by the end of the decade. America will develop this resource without putting the health and safety of our citizens at risk.
But perhaps this “projection” is built on shaky foundations. Here are a couple of articles that will raise your eyebrows:
In essence what has been happening is shale miners have been concentrating on “sweet spots” in shale formations and leaving less productive areas for later development.
So production results that we see are rather biased. Once sweet spots in shale formations are exhausted then it will prove very difficult to maintain the same production rates let alone increase the volume.
An added complication to this is the depletion rates of shale oil and gas wells. Shale wells start strong and fade fast, which means that producers have to drill at ever increasing rates just to hold output steady.
Changing Consumption “Patterns”
Cheap and plentiful natural gas is changing the consumption behavior of US industry. For the first time ever natural gas overtook coal for electricity production:
Wow! This is a radical step up in electricity produced by natural gas:
Plunging prices for natural gas, which have fallen alongside oil since last summer, led to it being used to generate 31 percent of America’s electricity in April, while coal contributed 30 per cent. This was the first month in US history that gas-fired electricity generation surpassed coal-fired generation, according to SNL Energy, a research firm — although it came close in 2012 when gas prices were also very weak. In 2010, coal provided 45 percent of US power.
And guess what? The forecast is for this trend to continue (surprise, surprise):
Isn’t that typical? Take the recent past and project into the future.
Not only do we have to contend with this trend of ever higher use of natural gas for electricity generation but there is the LNG angle as exports of LNG from the US are expected to rocket:
And by 2018 (that is next year), the US is expected to be a net exporter of natural gas:
In order for these forecasts to equal reality there will have to be one hell of a lot of wells sunk over the coming years, the likes of which we have not seen before. Because it seems to me expectations for endless cheap natural gas are changing what is likely to happen in the future.
Once again, I go back to that one liner by Nicholas Cage in the 2007 movie “NEXT:
Here is the thing about the future every time you look at it it changes because you looked at it.
A very strong case can be made that what appears to be a surplus of supply of oil and gas in the US and globally will likely turn into a deficit sooner rather than later.
And after a long period of neglecting to develop and discover oil from offshore sources it will take time to increase output of existing fields let alone discover others to replace deletion of fields already in operation.
I think once the crowd gets a hint that a deficit is developing in the oil and gas market and that shale reserves have been exhausted much quicker than ever expected, offshore oil and gas drilling stocks will rocket. Those that are still left, that is.
I say that there is serious upside on offer because all the dedicated offshore oil drillers are trading at levels suggesting bankruptcy is imminent and as if we won’t need oil or gas from offshore sources 5 years from now (something like that).
And how do the charts look? Or should I say, what is the market thinking?
There is no offshore oil driller index, but if we use two of the bigger players as proxies for the industry, we will get a fairly good idea as to what an index would look like.
Record lows. Seems to me that market is thinking that these stocks are about to enter bankruptcy and implying that there will be no need to drill for oil and gas from offshore sources ever again. Ever is a long time.
There has been a string of bankruptcies in the offshore oil sector already. Names that come to mind are OceanRig Int, Hercules Offshore, Vantage Drilling, Paragon Offshore, and now Seadrill:
Are these all contrary signs?
I wouldn’t get too concerned with a few smaller players going bankrupt but when a heavyweight like Seadrill files for bankruptcy (they have indicated they would do so in early September), that is a strong sign of a market that isn’t far from bottoming, if it hasn’t already done so. Remember Hanjin’s bankruptcy that signalled the bottom in the bear market for shipping stocks? For the time being, at least.
Take at the valuations of the drillers that aren’t in bankruptcy:
As far as I am concerned none of these stocks are in any danger of entering bankruptcy, at least for the next few years.
So with stocks priced for bankruptcy what happens to stock prices if something a little less worse than expected occurs? What happens if these (or most of them) survive this ferocious bear market when few ever expected them to do so?
Perhaps the biggest challenge is not so much as to trying to figure out whether or not to buy offshore oil drillers but rather which ones to buy.
Applying a Bullish View on Offshore Oilers
It would be easy if there was an “offshore oil driller” ETF but there isn’t. But no problem, we can create our own buy buying a basket of oilers. I’m going to go with the offshore oil drillers with the highest current ratio (indicating they have the most cash on hand). So I am choosing 4:
- Transocean – RIG
- Ensco – ESV
- Diamond – DO
- Rowan Companies – RDC
And one final word: Patience. I am quite prepared to be wrong (or at least not right) for a long period of time on this “trade”. I do expect stock prices of offshore oilers to be materially higher 5 years from now, but this isn’t to say that we couldn’t see them fall another 30% or so from current levels.
So if you do like the “story” but you wouldn’t be comfortable being down on the trade by 30% say 2 years from now then it probably isn’t a trade for you (perhaps stick with buying SPDR S&P Oil & Gas Exploration & Production ETF) and position size so that you can sleep well at night.
If this is the bottom and stocks only go up from hereon in, please don’t think I am some market timing genius. We’re quite simply just applying risk reward metrics here.
Trade Option 4
Buy Offshore Service Stocks
If you think the offshore drilling stocks have been ravaged, then offshore oil support stocks have been savaged. It seems a neck and neck race to get to the bottom.
As with offshore oilers, many offshore oil support stocks are more or less trading at generational lows. The stocks I have chosen have little or no debt and lots of cash on hand. So there is probably little chance of them going bankrupt like so many others have done so over the last few years.
The charts below aren’t exactly a technical analyst’s dream (rather a nightmare given the amount of noise in them). However, they do show a general reluctance to make new lows.
I am reasonably confident to stand up and say that they are at the bottom of their cycle and that the next big move is to the upside.
Gulf Island Fabrication (GIFI)
A fabricator of offshore drilling and production platforms and other steel structures for customers in the oil and gas, and marine industries in the United States. No debt, current ratio 4.6x, P/Book 0.65x.
Geospace Technologies (GEOS)
A manufacturer of seismic instrument and equipment for the oil and gas industry. No debt, current ratio 17x, P/Book 0.95x. Crikey!
Helix Energy Services (HLX)
The company provides specialty services to the offshore energy industry globally. It operates through three segments: Well intervention, robotics, and production facilities. It engineers, manages, and conducts well construction, intervention, and abandonment operations in depths to 10,000 feet; and operates remotely operated vehicles (ROVs), trenchers, and ROVDrills for offshore construction, maintenance, and well intervention services.
D/E 0.34x, P/Book 0.6x, current ratio 2.20x.
There are many other well run companies trading at generational lows. But this won’t last for too much longer.
Special Situations – Long-Term Warrants
Stone Energy Warrants
I have mentioned Stone energy in the Weekly Insider a few months ago.
In its own right, Stone Energy looks like a great trade. It came out of bankruptcy at the start of the year with a new look balance sheet (debt holders taking over the majority of the equity in the company as per usual).
As part of the restructuring long term warrants were issued with US$42.04 strike, 28 February 2021 expiry. Currently these warrants trade at US$2.50. One warrant gives you the right to buy 1 share at expiry.
The million dollar question: Can Stone Energy get materially above US$42 come February 2021? Well, that is 3.5 years away, which should be long enough for the price of crude to rise.
Payoff? Well that depends on where SGY closes come February 2021. Let’s say it closed at US$80 where it was trading mid-last year. The return would be (80 – 42.04 – 2.5)/2.5 = 1,418%. Not a bad hourly rate.
These are exchange traded warrants so they can be traded on most platforms (including Interactive Brokers).
What has been encouraging about Stone Energy is that it hasn’t gone down over the last 6 months when the average oiler has fallen by some 30%. It seems this stock has hit rock bottom.
I would like to think I am saving the best for last: 6-year call warrants on Tidewater.
As part of Tidewaters restructuring as it came out of bankruptcy, it issued two warrants
July 2023 expiry (6 years),
- Strike US$57.06, code TDWTW
- Strike US$62.28, code TDDTW
Let’s focus on the US$62.26 strike warrant. Below is its trading history. It wouldn’t be difficult to pick up $5,000 – $10,000 each day… so it is well off the radar of any hedge fund (as its volumes are too small) and also for retail traders (they wouldn’t know it exists let alone how to trade it). So I’m guessing only a few sophisticated retail traders are aware of it and are accumulating.
Yes, they do trade. My friend put a small order on last night and filled (I blotted his name out for privacy reasons). Note this is an OTC trade it doesn’t trade on an exchange. You can’t do these trades on IB (that I am aware of).
So how do these warrants work? They are just like options. If I were to buy 900 warrants today at US$1.25, it will cost me US$1129.95. Then I will have the right to buy 900 TDW stock at US$62.28 per share come July 2023.
For me the big question is just where will TDW be 6 years from now? Well, let’s put it this way: It will have either gone bust (again)/be a lot closer to zero… or it will be up a multiple of its current value.
I don’t think it would take much for TDW to close at US$100 come July 2023. It was way above US$100 in December 2016 and January 2017.
As I said, I was going to save the best for last.
So let’s assume that TDW does close at US$130 come July 2023. What would my friend make?
The calculations go like this (130 – 63.28 – 1.25)/1.25 = 5,300%. So my friends $1,129 will turn into US$59,837. Let’s call it US$60k.
Is that not a trade to make “The Big Short” boys water at the mouth? Just a couple of trades like this in your portfolio every 10 years or so can make one huge difference.
Of course TDW might not get to US$130 it might just be US$100 or it could be US$150. Time till tell as it always does.
I think the hardest part of this trade will be to do nothing. Because to get to a 50x return it has to get above 10x and who will be hanging onto this trade with the prospect of bagging a 10-fold return?
It is really hard to make a lot of money, or at least keep ourselves away of sabotaging huge returns.
Walk away and don’t look back is sometimes the best advice.
Good luck to you all.
Founder & Editor In Chief, Capitalist Exploits Independent Investment Research
Founder & Managing Partner, Asymmetric Opportunities Fund
Unauthorized Disclosure Prohibited
The information provided in this publication is private, privileged, and confidential information, licensed for your sole individual use as a subscriber. Capitalist Exploits reserves all rights to the content of this publication and related materials. Forwarding, copying, disseminating, or distributing this report in whole or in part, including substantial quotation of any portion of the publication or any release of specific investment recommendations, is strictly prohibited.
Participation in such activity is grounds for immediate termination of all subscriptions of registered subscribers deemed to be involved at Capitalist Exploits. Capitalist Exploits reserves the right to monitor the use of this publication without disclosure by any electronic means it deems necessary and may change those means without notice at any time. If you have received this publication and are not the intended subscriber, please contact email@example.com.
Capitalist Exploits website, World Out Of Whack, Insider, and any content published by Capitalist Exploits is obtained from sources believed to be reliable, but its accuracy cannot be guaranteed. The information contained in such publications is not intended to constitute individual investment advice and is not designed to meet your personal financial situation. The opinions expressed in such publications are those of the publisher and are subject to change without notice. The information in such publications may become outdated and there is no obligation to update any such information. You are advised to discuss with your financial advisers your investment options and whether any investment is suitable for your specific needs prior to making any investments.
Capitalist Exploits and other entities in which it has an interest, employees, officers, family, and associates may from time to time have positions in the securities or commodities covered in publications or the website. Corporate policies are in effect that attempt to avoid potential conflicts of interest and resolve conflicts of interest should they arise, in a timely fashion.
Capitalist Exploits reserves the right to cancel any subscription at any time, and if it does so it will promptly refund to the subscriber the amount of the subscription payment previously received relating to the remaining subscription period. Cancellation of a subscription may result from any unauthorized use or reproduction or rebroadcast of any Capitalist Exploits paid publication/s, any infringement or misappropriation of Capitalist Exploits proprietary rights, or any other reason determined in the sole discretion of Capitalist Exploits.
Capitalist Exploits has affiliate agreements in place that may include fee sharing. If you have a website and would like to be considered for inclusion in the Capitalist Exploits affiliate program, please email firstname.lastname@example.org. Likewise, from time to time Capitalist Exploits may engage in affiliate programs covered by other companies, though corporate policy firmly dictates that such agreements will have no influence on any product or service recommendations, nor alter the pricing that would otherwise be available in absence of such an agreement. As always, it is important that you do your own due diligence before transacting any business with any firm, for any product or service.
© Copyright 2017 by Capitalist Exploits